Daqo New Energy: A cheap Chinese stock in a growing market.

Like many other Chinese stocks, Daqo New Energy is currently trading at a cheap price below its book value. Furthermore, they are operating in a growing sector, which should result in tailwinds for a substantial time. If investing in Chinese stocks, you will need to stomach the volatility but is an investment in Daqo New Energy too good to pass?

This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.

This analysis will be a bit different from what you are used to read in my blog. Daqo New Energy did their IPO in 2021, meaning I don't have access to the historical numbers dating back longer than that. So instead of using the principles I have learned from my Phil Town workshop, I use the principles I have learned from the GOAT academy. I should also mention that most of the numbers I use in this analysis is from Finbox, which I believe is a great tool to get different numbers from various companies.

Before I start with the analysis, I should mention that at the time of writing this analysis, I do not own shares in Daqo New Energy. However, I do have exposure to the solar/polysilicon sector, as I own Canadian Solar. If you would like to see or copy my portfolio, you can read how to access it here.

Daqo New Energy is a Chinese company that was founded in 2008 but didn't IPO until 2021. It is a leading manufacturer of high-purity polysilicon for the global solar photovoltaic industry. It is one of the world's lowest cost producers of high-purity polysilicon. All Daqo New Energy's manufacturing operations are based in China. They have operations in the Xinjiang operations, and is now expanding to Inner Mongolia, which is an autonomous region in China. In 2022 they produced 133.812 MT of polysilicon, while they in 2023 expects that production will 190.000 to 195.000 MT. Daqo New Energy is third largest polysilicon producer in the world, trailing Tongwei and GCL Technology, which are both Chinese as well. Chinese producers benefit from subsidized capital expenditures, low raw material and labor costs, as well as cheap electricity costs, which means that Chinese producers have built a moat compared to producers from other countries. While there are still competition inside China, I would say that Daqo New Energy has a toll moat that protects from international competition.

Their CEO is Longgen Zhang. He joined Daqo New Energy as a CEO in 2018. Prior to joining Daqo New Energy, Longgen Zhang served as the CFO at Jinko Solar. Prior to working in the solar industry, he was the CFO in another U.S. listed company, Xinyuan Real Estate, while also being the CFO in Crystal Window and Door Systems, which is an American company. He holds a bachelor's degree in economic management from Nanjing University in China and a master's degree in professional accounting and business administration from West Texas A&M University in the United States. Longgen Zhang is also a member of American Institute of Certified Public Accountants. He was chosen as CEO of Daqo New Energy because of his experience and knowledge of the global solar industry and financial markets. It is hard to find much information about Longgen Zhang, but I think it is an advantage that he is educated in both China and the United States, while also having experience working on both countries. He also has vast experience in the industry from Jinko Solar and Daqo New Energy, which is why I feel comfortable with him leading Daqo New Energy moving forward, despite not having much information about him.

I believe that Daqo New Energy has a toll moat. While I don't have much information about the management, I will give it the benefit of the doubt because of the vast experience in the sector. Later I will do a discounted cash flow model to calculate a price for Daqo New Energy but before I do so, let us just have a look at some key financial metrics.

Down below we see some key financial metrics for Daqo New Energy. The revenue growth has been extraordinary from year to year as they have more than doubled their revenue each year since 2020. Not only have they experienced tremendous growth in revenue, but margins have also significantly improved. The gross profit margin they reached in 2021 at 65,4 % is impressing, yet they managed to grow the gross profit margin to impressing 74,0 % in 2022. Operating margin, EBITDA margin, and EBIT margin have all increased year over year as well, meaning the company is getting more profitable. EPS have also tremendously increased year over year. I cannot really find anything negative to write about these numbers and I'm astounded with the numbers that Daqo New Energy have managed to deliver over the years.

Despite the astounding results, no investment comes without risk, and there are risks when investing in Daqo New Energy as well. One risk is the price of polysilicon. Daqo New Energy is very sensitive to the price of polysilicon, and while the price of polysilicon was record high in 2022, it has since dropped and is now trading at the same price as it did in 2021. Furthermore, it isn't only Daqo New Energy that is increasing their production of polysilicon, so are some of their competitors, and as more polysilicon is entering the market, it could drive the price further down. Another risk is customer concentration. Daqo New Energy has a high customer concentration as three of their customers accounted for 61,4 % of their revenue in 2021. The reliance on the three customers has decreased as they contributed to more than 80 % of the revenue in 2019, but customer concentration is still a risk, as if Daqo New Energy should lose one of their large three customers, it would affect their business significantly. Finally, we cannot avoid the China risk. There are risks when investing in China. At the time of writing this analysis we have geopolitical tensions between the United States and China, and if these spiral out of control, it will hurt all Chinese stocks. Hopefully, it won't spiral out of control but even if it doesn't, it will fuel the negative sentiment towards China. The Holding Foreign Companies Accountable Act hasn't been resolved either and while management was optimistic in the Q4 2022 earnings call, it is still a risk until it is resolved. Finally, Daqo New Energy has operations in Xinjiang, a region that is come under scrutiny because of forced labor. And while Daqo New Energy has opened their factory for journalists and Daqo New Energy wasn't mentioned in the list on companies using forced labor in Homeland Security's report to Congress on forced labor in China, it is something to be aware of as Daqo New Energy obviously becomes "uninvestable" if they are using forced labor.

There are also reasons to invest Daqo New Energy moving forward. The solar sector will grow. According to Global News Wire the polysilicon market is expected to grow by a CAGR of 7,3 % until 2027, while Contrive Datum Insights are more positive and expects that the global polysilicon market will reach $27,07 billion by 2030, which means it will grow by a CAGR of 13,2 % until 2030. While there can be some differences in the annual growth rate, we will see a worldwide transition into green energy in the upcoming decades, and Daqo New Energy should benefit from this transition. In the Q4 2022 earnings call, management mentioned that the energy transformation to green energy is still in an early stage and that the potential is likely to be far beyond expectations. Daqo New Energy will be profitable even with lower polysilicon prices. The average polysilicon production cost for Daqo New Energy was $7,78//kg in Q4 2022, while the average polysilicon selling price was $37,41/kg in the same quarter. Hence, Daqo New Energy still has plenty of room for the price to drop and still be profitable. Management has also mentioned that they outperform most of their peers in terms of unit profitability, cost structure, and product quality. Management also mentioned that they will continue to generate significant cash flow as they are the lowest cost producer in the world with some of the highest quality. The stock is cheap. As I write this, the stock of Daqo New Energy is trading below the book value per share of $64,65. Furthermore, management has introduced a $700 million share buyback program, and that is at a current market cap of $3,9 billion! Hence, when executed the share buyback will significantly decrease the amount of shares.

I have now investigated the financials, risks, and potential of Daqo New Energy. I will now look at the price by doing a discounted cash flow model. To do so I will need some numbers that you can see below. The numbers are the 2022 numbers, which I could find at Finbox. However, the perpetuity growth rate and the discount rate are numbers I have come up with myself. The reason I chose 3 % as perpetuity growth rate is that it is usually a between the historical inflation rate of 2-3% and historical GDP growth of 4-5%. I decided to go with 3 %, which is a figure in the middle due to the current market conditions. The chosen discount rate of 12% is because it is usually between 9-12%. I decided to go with the highest one because of the lack of moat. Remember that all the numbers made in these calculations are in millions.

I also need to determine how much EBIT, Depreciation & Amortization and Net Working Capital will evolve over the next couple of years. According to Finbox, EBIT is going to decrease at average -26 % over the next five years. I'm not sure that I agree but I have made two calculations. Once in which EBIT decreases by 20 % each year for the next 5 years and one where it stays as it is. Hence, I have made no calculations with EBIT growing despite it has grown an average 173 % a year over the last five years. I decided to keep Depreciation & Amortization flat as well, despite it was growing an average 40 % a year in the last five years. Finally, I have made two calculations with Net Working Capital (NWC). One where it stays flat and one where it decreases by 10 % a year. Finbox expects Net Working Capital to decrease by 14 % a year over the next five years. The results were as following: If EBIT decreases by 20 % a year and NWC stay flat, intrinsic value would be $110. If EBIT decreased by 20 % a year and NWC decreased by 10 % a year, intrinsic value would be $125. If EBIT stays flat and NWC stays flat, intrinsic value would be $219. If EBIT stays flat and NWC decreased by 10 % a year, intrinsic value would be $234. Hence, in my most conservative calculation, the intrinsic value of Daqo Ne Energy is $110.

Having investigated Daqo New Energy, I'm impressed with the numbers that they have managed to deliver. While there are some unknowns regarding management, I still feel that the experience of the CEO is enough for me to be comfortable in investing in the company. Margins will probably decrease if the price of polysilicon decreases but I believe that Daqo New Energy will continue to be highly profitable. The China risk is something that can be hard to stomach but it is something I'm comfortable with as I'm invested in other Chinese companies. Daqo New Energy not being mentioned in the Homeland Security report is encouraging, as I must believe that they have been investigated thoroughly. However, if at some point proofs show that they have been involved in forced labor, the company will obviously be "uninvestable" for me and should be for everyone else, but until then I see no reason not to invest in a high margin, high profitable company that is operating in a growing market. I believe that Daqo New Energy is a buy below its book value of $64,65, and even more so at $55 as it would trade at a 50 % discount to my very conservative calculations.

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